Presentación de resultados de las entrevistas

3.3.1. Is it possible to achieve both profitability and poverty outreach?

One of the most controversial issues in microfinance has been the extent of the trade-off between profitability and reaching the poorest clients. These two objectives are the cornerstone of the microfinance industry and it is a very controversial issue whether these objectives are in conflict. Many of the studies today have found trade-off between profitability and outreach to some extend (e.g. Mosley, 1996; Mosley and Holme, 1998; Galema and Lensink, 2009; Hermes et al. 2011). Still there are other studies that show that the trade-off is not significant or it exists only in certain situations (e.g. Gonzales and Rosenberg,

2006; Cull et al., 2007; Hishigsuren, 2007; Mersland and Oysten, 2010; Mersland and Strøm, 2010; Quayes, 2012). The trade-off refers to a situation that institution would not be able to achieve high profitability without losing its outreach to poor people. If the trade-off exists, it means that profitable institutions are not able to reach the poorest of the poor, who need the microfinance services most. If trade-off would not exist, it means that institutions with higher profitability are able to generate more revenues or reduce more costs compared to less profitable institutions. They are therefore able to compensate higher cost of reaching the poorest in some other way. If the trade-off would not exist, it would indicate a positive future for commercialized microfinance institutions. Those would have a huge profit generating and poverty reduction potential.

Trade-off between profitability and depth of outreach stems from the fact that transaction costs have a fixed cost component so that unit costs for smaller savings deposits or smaller loans are high compared to larger financial transaction (Zeller and Johannsen, 2006). Cull et al. (2009) states that when both large and small loans require similar outlays for screening, monitoring, and processing loans, the small loans will be far less profitable unless interest rates and fees can be raised substantially. This law of decreasing unit transaction costs with larger size transactions generates the trade-off between financial sustainability and improved outreach to the poor (Zeller and Johannsen, 2006). In addition, Cull et al. (2011) find that administrative costs per dollar lent are much higher for small loans than for large loans, the interest rates necessary to cover all costs (including costs of funds and loan losses) are much higher for MFI loans than for conventional bank loans. There are also opposite hypotheses and for example Quayes (2012) finds out that lower costs are associated with smaller sized loans. This may be due to the fact that the terms and conditions of small loans are standardized and routine, and as such have a lower cost per borrower. Quayes (2012) also notes that many group loans are smaller in size and require lower cost of monitoring on part of the MFI management. In contrast, relatively larger loans may entail higher administrative costs and result in a higher cost per borrower. The trade-off between profitability and outreach would imply that shifting focus towards increasing sustainability and profitability reduces the scope for the more traditional social aim of the MFIs to serve the poorest people.

To cover the higher costs of providing small loans, MFIs may set higher interest rates or reduce their costs. Cull et al. (2007) find the evidence that there is the possibility of earning profits while serving the poor but it often demands high interest rates. Due to these higher interest rates, also MFIs that offer relatively small loans are able to make a small profit (Cull

et al., 2009). Ylinen (2010) also explores that there are advocates that promote the idea that interest rates should be raised to cost-covering levels. On the other hand economic theory finds several reasons why the rates should not be raised too high. Cull et al. (2007) also find that raising fees to very high levels does not necessarily ensure greater profitability. Most of the researchers suggest that it is not the target to provide small loans with extremely high interest rates. That is not a good way to reach poverty reduction. Ylinen (2010) concludes that even though some poor people have proved to be able to pay high interest rates, it does not mean that they all can because the non-financial abilities of the poor vary greatly. Therefore, improving efficiency could help enlarge market penetration and improve profitability of the MFIs. Through efficiency, MFIs are also able to facilitate the social mission, when they can pass the cost savings into lower interest rates.

Mission drift means that institutions would suffer even larger tradeoff between profitability and poverty outreach while they grow and mature. Mission drift can be used as a synonym for the trade-off studies but it is easily mixed with cross-subsidization or progressive lending and therefore it is not easy to determine. Mission drift is widely used concept in microfinance discussions which tries to answer to question: Have microbanks moved away from serving their poorer clients in pursuit of commercial viability? Armendáriz and Szafarz (2011) define mission drift as a phenomenon whereby an MFI increases its average loan size by reaching out to wealthier clients neither for progressive lending not for cross-subsidization. One general mistake is that it would be necessarily bad to provide financial services to the wealthier clients even though it is usually necessary to be able to serve the poorest clients in a profitable way. Based on the Armendáriz and Szafarz (2011) cross-subsidization occurs by mixing richer and poorer customers. This helps microfinance institutions to meet their outreach-maximization objectives, particularly when the continued flow of funds from international donors/local governments and socially responsible investors is biased in favor of self-sustainable institutions. Armendáriz and Szafar (2009) bring up a very relevant point that maybe mission drift should not be measured only based on the customers that MFI is lending to. Should for example high interest rates for monopoly holding MFI be included to the definition of mission drift? Too high interest rates from the poorest of the poor are not clearly aligned with the poverty reduction mission.

It is also important to note that the question is not black and white and clearly the effect will exist in some situation with some conditions. Gonzales and Rosenberg (2006) state, the practical question is not whether there is some trade-off between MFI profitability and client

poverty, but whether such a trade-off has significant force in the circumstances in which most MFIs are actually operating. Gonzales and Rosenberg (2006) define that in the first place some potential borrowers who are extremely poor, have no reliable source of income from which a loan could be repaid, and lack the opportunity to start microbusiness. They also state that secondly, some very poor people live in remote and sparsely populated areas where administrative costs of lending are extremely high, and where interest rates would have to be correspondingly high to cover those costs. Clearly it cannot be profitable to lend to people who are unlikely to repay. Therefore there are exceptions and poverty outreach doesn't mean that each individual poor would be reached. Trade-off studies rather investigate whether poor people can be reached in a large scale while maintaining profitability of the operations.

3.3.2. Empirical evidence of the trade-offs

There are some cross-country studies relating to the tradeoff between profitability and outreach. Proponent of the existence of the tradeoff is for example Mosley (1996) who studies the change from NGO to commercialized bank. He explains that objectives to reduce poverty and achieve financial self-sufficiency are often conflicting. He claims that poverty reduction decreases with the loan sizes whereas financial performance improves with loan size as economies of scale are reaped. In addition, Hermes et al. (2011) find that MFIs that have a lower average loan balance or MFIs that have more women borrowers as clients are less efficient. One important reason is the higher cost for borrowing to the poorest. In addition, if MFIs focus on maximizing efficiency, mission drift might be stimulated, since MFIs serving the poorer parts of the population are less efficient. Also, Galema and Lensink (2009) explore that MFIs face a trade-off between returns and outreach, since it is more costly to borrow to very poor borrowers. They also face a trade-off between risk and outreach, since it is typically more risky to finance the types of MFIs that serve the poorest borrowers. Moreover, Armendáriz and Morduch (2010) state that recent studies have shown a correlation between commercialization and a decline in the percentage of female clients as a share of total clients.

On the other hand, there are several studies that show that institution could achieve both profitability and poverty outreach. For example Quayes (2012) concludes that there is complementary positive relationship between depth of outreach and financial self-sufficiency. He concludes that it does not matter whether the financial sustainability is self-imposed by MFI or required by the donor agencies. Also Gonzales and Rosenberg (2006), using data of 2600 MFIs, show that there is no conflict between financial sustainability and outreach. They

show that there is no indication that serving poorer customers tends to hurt financial performance seriously. In addition, for example Hishigsuren (2007) concludes that institution won’t drift from their mission because the deliberate decision by the management but more because of the challenges posed by the scaling-up process. He researched only very limited number of institutions in India to see if the trade-off is existent in some specific situation. He finds out that the MFI has not drifted from its poverty alleviation mission significantly when the drift is measured in terms of depth, quality, and scope of outreach. There are some minimal shifts but those are not large enough to indicate abandonment of the poorer members.

There are also several studies that find trade-off existing for some of the institutions but not for all of them. These studies indicate that tradeoff may be a problem in a certain situations. For example Mersland and Oystein (2010) find that the average loan size has not increased in the industry as a whole, nor is there a tendency towards more individual loans or a higher proportion of lending to urban customers. Nevertheless, Mersland and Oystein (2010) found that inefficient MFIs need to shift their loan portfolios toward larger average loans and are then most susceptible to mission drift. They also find that when an MFI increases its cost efficiency, it is better able to advance loans to the poorer members of the community. In addition, Cull et al. (2007) find no evidence on trade-off between their measures of profitability and outreach. They find some institutions that have both achieved profitability and meaningful outreach to the poor, but disaggregation by lending-type reveals trade-offs between the two objectives. Individual-based lenders as a group have the highest average profit levels, but they perform least well on measures of outreach. Individual based lenders find it cost effective to increase the average loan size. The lenders need to consider whether it can make sense to shift focus to wealthier borrowers who can absorb larger loans, even at the sacrifice of outreach to the poorest segments in a community (Cull et al., 2007). They also find that larger and older microbanks focus increasingly on clients that can absorb larger loans. Morover, Zeller and Johannssen (2006) did the research about the poverty outreach depending on the type of institution in the Peru and Bangladesh, in two counties where there is a long developed microfinance sector. The analysis shows that microfinance institutions are able to reach the poor, but that also a large share of their clients belongs to the non-poor population.

Differences in trade-off may therefore depend on the institution types, but also on the environment that MFI is operating. Vanroose and D’Espallier (2013) conclude that based on their market-failure hypothesis, mission drift is less likely in the countries with well- developed financial systems. MFIs serve poorer people in countries with well-developed

financial systems. In the countries with well-developed financial systems, traditional financial institutions and microfinance institutions stand in more direct competition with each other. This competition pushes MFIs down the market and makes mission drift by MFIs more likely. In addition some other studies find only slight or no evidence of trade-off in a microfinance industry as a whole, but the trade-off is often evident when dividing the sample to smaller groups.

There has also been discussion on incentives for MFIs to prevent the trade-off between profitability and outreach. Aubert et al. (2009) show how a positive correlation between wealth and repayment gives rise to problems in designing internal incentives for agents in pro-poor MFIs. They explore the situation where the costs of acquisition of information on wealth and auditing are high and the share of very poor in the population of potential borrowers is large. In this case, MFI will prefer to give incentives to agents to select based on the ability of repayment forgetting poverty levels. To bring up right kind of incentives, pro- poor targeting can be done by selecting impoverished geographical areas or by using financial products that are only attractive to poor borrowers. The problem arouses because some large areas are left uncovered and the method has a cost on the poor. For these reasons, improving methods to gather information on wealth and carrying low-cost audits is a priority to prevent mission drift among pro-poor MFIs.